Wednesday, October 29, 2014

The L-word

Lowflation is the new dirty word now. The Economist says that deflation, not lowflation, in Europe is the world's biggest economic problem. But they also suggest that low inflation (lowflation is the neologism; some suggest that the term was coined by Reza Moghadam from the IMF) is as bad as deflation. In a recent article they note that most countries are undershooting their official or unofficial inflation targets. The Economist says:

"In America, Britain and the euro zone central banks have a 2% target for inflation. In all three, it is below that target. In Italy, Spain and Greece, which have experienced wrenching crises and recessions, it is below zero (as it also is in Sweden and Israel). Japan, which finally escaped from deflation in 2013 after more than a decade of struggle, is battling not to return. Leave out the effects of a consumption-tax increase and inflation there is barely half way to its 2% target. Even in China inflation is below 2%, compared with a 4% central government target (see chart 1)."

They also suggest that the: "the catalyst for the latest deflation scare is ... [the fall in] the price of a barrel of oil ... from $115 at the end of June to about $85 today, prompting a sharp drop in headline inflation." Yes lower commodity prices might play a role, but it is the weak recovery and the excessively contractionary policies in developed countries that are to blame for lowflation.

The Economist at least gets the dangers of lowflation/deflation right, and it's pure Keynes. They say that: "The belief that money made tomorrow will be worth less than money today stymies investment; the belief that goods bought tomorrow will be cheaper than goods bought today chokes consumption." Keynes version of debt-deflation emphasized more the effects of falling prices on debt and investment that consumption, but is essentially the same point. He said: "if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, — with severely adverse effects on investment."

Also, The Economist reports that even Wall Street economists (admittedly Buiter is an Old Keynesian with ties to Jim Tobin) like:

"Willem Buiter of Citigroup thinks this [fiscal expansion] would be a 'no-brainer' for America, which badly needs better public infrastructure and which can issue virtually unlimited volumes of treasury bills thanks to the dollar’s reserve currency status. In Europe, Mr Buiter says, the equivalent would be for the EU to permit peripheral countries to run larger deficits with the ECB independently initiating QE to buy the resulting bonds."

This is relevant, since today many expect the Fed to announce the end of QE.